Income smoothing through loan loss provisions in Asia–Pacific commercial banks: the role of managerial ability

What the paper says

Purpose This research aims to answer the question of to what extent managerial ability (MA) impacts the level of employing income smoothing (IS) through loan loss provision (LLP) and how this influences the banks’ financial performance. Design/methodology/approach The research confirms LLPs used to smooth income through the relationship between LLPs and pre-provisioning income in Asia–Pacific banks from 2012 to 2021. Then, it explores the role of managerial ability in IS behavior by using a two-stage procedure: estimating the profit efficiency by employing a four-error stochastic frontier analysis (SFA) and generating MA by calculating residuals from regressing profit efficiency on bank-specific factors. Next, it explores the relationship between IS, managerial ability and banks’ performance. Findings There is IS through LLP among Asia–Pacific banks, and high-ability managers generally have no special taste in utilizing IS. However, these situations could be modified by contexts such as bank types, profitability levels, credit risk or economic conditions. Besides, talented managers are expected to propose a positive impact on performance in case they use discretionary LLP as a tool of IS. Originality/value This study is among the first to discover IS behavior and its association with MA and performance in the banking industry and Asia–Pacific region. Furthermore, a four-error SFA can solve the problems of inability and improve the measurement framework of managerial ability measurement. The research also enhances the understanding of upper echelon theory.